Bilateral Trade between India and Canada: An Error Correction Model

The improvement of the trade balance of India vis-à-vis Canada can be attributed to the devaluation of Indian rupee as a part of the reform program in July 1991 and the subsequent depreciation of the Indian currency owing to the managed floating exchange rate regime. However, but for the increasing inflation in the post-reform period, the result could have been more in favor of India. Thus, the obvious policy prescription for India is to reduce the inflation rate so that the impact of devaluation and depreciation will be more prominent on the trade balance, at least with Canada. This suggestion can be tentative as inflation in India could have been unavoidable owing to its other compulsions. However, the negative response of export of India to its GDP and its perceived fluctuation in the short run could be a major cause of concern to the policy makers.

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Introduction

Over the last three and a half decades, the world trade has gone up considerably and in fact the growth of world trade (5.7%) has outpaced the growth of world output (2.82%) (Rao, 2005). The sustained effort of most of the world economic powers toward globalization could be a major reason for this. However, in this world of globalization, the emergence and successfulness of the Regional Trading Blocks (RTBs) sound paradoxical. At this juncture, it is pertinent to know whether this development in the world economic scenario has deterred the importance of bilateral trade. Notwithstanding the question of globalization and the successful emergence and functioning of the RTBs, bilateral trade is definitely of importance, particularly to the developing economies and to the economies of transition like India. Thus, this area deserves its due attention as growth in bilateral trade is the basic premise for the growth of world trade and/or trade among the members of the RTBs. The Indo-Canadian trade during the above-mentioned period has not been at par with the global scenario. This could be due to the fact that Canada did not have much trade links with the South-Asian British Colonies and India was one of them. Moreover, there was hardly any scope of growth of India's trade volume with Canada because of the prevalence of constraining tariff agreements before the 1980s. A host of other perennial factors also contribute toward this, like the geographical distance and widespread disparities in the socioeconomic structure of the two countries (Nair, 2007). However, the situation in the new millennium is encouraging for India. Canada's trade with India as percentage of Canada's total trade is increasing (Table 1 and Figure 1). A host of trade promoting policies of Canada can be accounted for this and the effective functioning of Export Development Canada (EDC) has helped the cause more. On the other hand, the growing favorable Trade Balance of India (TBi ) vis-à-vis Canada is definitely a healthy sign for India. A set of commonalities between the two countries like parliamentary democracy, free press, legal system based on the British law and the unity in diversity can work for the promotion of trade.

However, in the literature of Indo-Canadian economic relation the diasporic connection is disproportionately highlighted. But, this diasporic connection hardly supports the favorable TBi vis-à-vis Canada (Nair, 2007). In the literature of international trade, the role of exchange rate in promoting trade is well documented. But, hardly any study has tried to explore this dimension of Indo-Canadian trade relation. The present paper in an endeavor toward exploring this facet of the Indo-Canadian trade relation. The bilateral real exchange rate of Indian rupee vis-à-vis Canadian dollar (BRERic ) has been depreciating over a period of time (Table 2 and Figure 2). The degree of depreciation varies across different policy regimes, i.e., before and after 1991 (the period of liberalization). In order to unearth the impact of this liberalization of India on the bilateral trade between India and Canada, the study considers the period from 1980 to 2004. …

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